Asset Allocation and Risk Measures

Investing isn't just about stocks and funds. It's about knowing asset classes. It's about asset allocation between a range of investment vehicles such as bonds, real estate, commodities, and cash. Ideally, the range of investment vehicles should have a negative coorelation. In my opinion, every serious investor should have a well defined asset allocation strategy. I've provided a brief overview of my allocation strategy as an example. I do not recommend that anyone blindly follow this same allocation. Each person should have an asset allocation strategy that is tailored for their individual needs.

40% of my investment allocation contains stocks that I never intend to sell. Stocks of large companies with long term competitive advantages that have fallen out of favor. Strong balance and cash flow sheets are a requirement. Long track records of dividend growth is also a requirement. An international presence is a plus. Stocks are purchased based on solid fundamentals (Low P/E, Low P/S, High ROA and ROE) Investment strategies such as the Dogs of the Dow initially sparked my interest in such investments. Large companies generally have such low volitility, it gives an investor plenty of time to create a position and dollar cost average throughout the year. The underlying fundamentals of these companies generally do not change quickly. I have a spreadsheet filled with companies I would love to own. Usually, there are 1-2 a year that are on sale. During that year I make periodic purchases of these stocks. At times I think this strategy is so simple and powerful that I should increase the percent I allocate to it.

15% of my investment allocation is split between companies with a market cap of less than 10 billion and commodity/energy/utility stocks. Generally, these positions will be held for a minimum of 1 year for tax considerations. Ideally, most of these companies are bought and sold in an IRA or 401K to further minimize the tax consequences. I'm not going to go into too much detail into this section. Interestingly enough, the majority of my research time is spent on this specific area as it encompasses such a broad base of stocks. I've been a commodities bull for the past few years so logically I'm a bit overweight on commodity/energy/utility stocks. Generally, I try to stick with companies with a market cap of more than 1 billion simply because it's easier to see how the business has and will grow. The 10-Ks and 10-Qs generally provide much more information for mid caps than small and micro caps. I will say that I'm not afraid to put money into thinly traded companies with a market cap of less than 200 million. Every investment book I've read recommends against investing in micro caps. This may be true if your in charge of managing millions of dollars. But for the small investor, this is where a significant amount of money can be made. It only takes a single big investor or hedge fund to drive up the value of a micro cap.

15% of my investment allocation is dedicated to a select number of mutual funds. In general, I'm not a big fan of mutual funds. Essentially, your investing in additional administration and overhead when you buy into a mutual fund. Money managers in general have underperformed the market over the long term. I only invest in managers who have a track record of over 15 years of beating the market. I also have some funds that religiously follow a predetermined investment strategy. In the future, almost all additional funds I add will be index funds. This may seem contradictory since I believe it's possible to outperform the market for very long periods. I consider this to be my investment insurance policy.

15% of my investment allocation is dedicated to bonds, CDs and T-bills. Right now, I don't own any investment maturing more than 1 year in the future. In my opinion, investors are not be adequately compensated for long term risk in this area today.

10% of my investment allocation is dedicated to physical precious metals. This is probably the most controversal of my allocation strategy. The value of silver and gold will never go to 0. The fact that as investment vehicles silver and gold have been neglected for so long makes them that much more appealing to me. Many have noted the long term return of gold is dismal. I would like to point out that the US has only been off the gold standard since 1971. In the grand scheme of history this is a very short period. The verdict is still out on whether precious metals are viable long term investments. I think if you look at the performance from 1971 until the past few years you will notice that the tides are changing. History has shown us that no fiat currency has ever lasted. I like to tell my friends that I hope to be trading silver and gold for real estate in the near future. I joke that if things don't work out and the commodities boom has ended then I guess I will able to purchase a few good suits.

5% of my investment allocation is dedicated to REITs or real estate. To be honest, I don't own any REITs at this time but I do own a home.